Monday, February 10, 2014

Front-loading your 401k

The most common way of contributing towards your 401k is by setting aside a percentage of each paycheck. With a bi-weekly paycheck (once every two weeks), to max out the annual contribution limit of $17,500 (as of 2014), you would put in $673.08 per paycheck. While this strategy has many benefits in its simplicity and amortization, it is not the most optimal in terms of maximizing the long-term value of your retirement account.

Time is your most valuable asset in both saving and investing. If you are certain about how much you will contribute this year, then it is better to make that contribution as early on in the year as possible. This will give you a little extra time to let that money grow.

How much growth? Let's compare the two extreme examples: loading your 401k at the beginning of year versus loading it all at the end of the year. The difference between the two is a whole year of compounding. At a 10% growth rate, a front-loading a $10,000 contribution would net you an extra $1,000 by the end of the year. Assuming a consistent growth rate, that extra $1,000 will become over $2,593 in 10 years and over $17,000 in 30 years. And not only that, but you'll be able to reap the same rewards each year.

Example graph of net 401k value using each of the three contribution strategies assuming the same total yearly contributions.

If you compare front-loading to an amortized contribution over the course of a year, the benefit is approximately half of the above - still a very significant amount.

However, there are a few drawbacks that come with this more aggressive strategy:
  1. You must know how much you will contribute ahead of time.
  2. You must have an adequate amount of money saved up at the beginning of the year since your paycheck will be significantly diminished.
  3. Negative economic growth will also be amplified.

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Obligatory Disclaimer

The author is not qualified to give financial, tax, or legal advice and disclaims any and all liability for this information.